Singapore Stock Market News

Management

Three of the founders of Hongguo, Chen Yixi, Li Wei and Miao Bingwen are serving in the board as directors. Chen Yixi is the executive chairman, Li Wei is the Managing director and Miao Bingwen served as the executive director until 1st March 2007, where he became a non-executive director.

There is no employee stock options plan, hence no issues of the shareholder’s stake in Hongguo diluted. Furthermore, there is no stock buyback by Hongguo. There are no employees who are immediate family members of a director and whose renumeration exceeded S$150,000 since FY03.

Here is the breakdown of the founder’s salary indirect plus direct interest held:



We can see that the founders hold a substantial stake of their personal wealth being a stakeholder of the very own company which that set up. The executive chairman, Chen Yixi, alone holds 25.8% (direct and deemed interest combined) of the shares outstanding of Hongguo. Based on a market capitalization of SGD 204 million, that’s a cool SGD 53 million just by Chen Yixi alone. As a whole, the founders hold a 46% stake in their own company – a sure sign of confidence in their own baby.

There is ample planning and disclosure of the management’s plan for Hongguo, all stated clearly in their annual reports. It’s important to check this against what had been done over the years. Below shows the plans laid out and the check if the plans are carried out in the future:



I think the management did a very good job informing shareholders what they intend to do, so that they are no surprises. Their plans for expansion of their POS are very close to the actual POS set up in the future. Furthermore, all their design output targets and annual production targets that are set way in advance had been met uncannily.

A final look at the ROE and ROA will wrap up my analysis of the management of Hongguo. ROE is consistenly around 21-22% range, averaging 22.2% over 5 years since listing in 2003. ROA is improving from 13.66% in FY03 to 16.26% in FY07. Both of these figures show a certain level of competence in their business and management skills.

I find it very interesting that Prime Success and Belle are eagerly pursuing the sportswear segment and cited that the coming Olympics are going to ignite this sports fever in China. However, Hongguo did not once mention about going into the sportswear segment despite the show of confidence by their competitors. Doing business within their own circle of competence or too slow to respond to changing competitive landscape? Time shall tell.

What needs to be done is to attend their AGM.

Financial health of Hongguo

In the midst of analyzing the ROE, I’ve calculated the financial leverage ratio. Financial leverage ratio gives a good feel of the amount of leverage used. The figures are as shown:

Financial leverage---------Year
1.44--------------------------2003
1.43--------------------------2004
1.46--------------------------2005
1.38--------------------------2006
1.37--------------------------2007

Judging from the ratios, we can see that Hongguo isn’t overly extending itself. In fact, it should be less leveraged as the years go by. Let’s take a closer look to see if the financial status of Hongguo is as shown by the financial leverage ratio shown above.



Debt to Equity (total liabilities/share holder’s equity)

Debt to equity of Hongguo decreases steadily from 2002 to 2007, which is what is suggested by the financial leverage ratio. Looking at the balance sheet, there are only two years, 2003 and 2004, in which Hongguo had long term liabilities in the form of term loans. After that, there are no more long term liabilities.

On the other hand, Prime has a higher Debt/equity ratio (about twice as much) than Hongguo. This can also be seen by their higher financial leverage ratio shown in earlier post. Belle is harder to tell, since there is only one year since listing to compare.

On the whole, I’m very satisfied with the debt/equity that Hongguo has. It’s the second lowest among the three. A debt/equity averaging 0.43 since listing in 2003 is definitely not a sign to worry about.

Current and Quick ratio

Current ratio of Hongguo shows a slight downtrend. Considering that in FY07, its current assets are more than enough to pay off its current liabilities 2.77 times, I’m hardly worried. Even a more conservative quick ratio suggest that in the same year, the current assets without taking into account Hongguo’s inventories can pay off its current liabilities 1.46 times. Since Hongguo only has current liabilities, I think we can safely give Hongguo a clean bill of financial health.

Prime has a lower current ratio and quick ratio, with quick ratio less than 1 throughout the years. While I don’t think it is having any insolvency issues near term, I dare say that Hongguo has a stronger balance sheet than Prime. Belle has a rather strange current and quick ratio, but let’s not bother too much into it for now.

To add the cake to the icing, let’s take a look at the amount of cash that each company holds as a percentage to their total assets.

Cash/Total assets (%)--------02--------03--------04-------05-------06-------07
Hongguo-----------------------4.9------35.9------14.5------10.3-----12.2-----10.3
Belle-----------------------------------------------------------------------6.8-------38.5
Prime Success----------------16.8------18.0------11.8-----10.2------8.7-------7.7

I’ve a feeling that Hongguo management wanted to grow, but at a sustainable pace backed by a series of successful points of sales (POS) and funded by their own internal cash flow generated. They can borrow from banks to really aggressively open up new stores, but they didn’t. In fact, they are sitting on around 10% cash out of their total assets. While this might hinder their growth somewhat by not aggressively pursuing an all out approach to expand, I believe this prudence will bring about a longer and more sustainable growth in their business over time.

Here’s Hongguo’s financial health report – a strong balance sheet with around 60% equities and 40% debts on average, no long term liabilities or bank borrowings in recent years and with enough assets to pay off their liabilities at least 1.5 times over. I’m more than satisfied with them.

What a prolific day today! I had one of the free-est saturday that I can recall from recent memories. I managed to finish Peter Lynch's One up on wall street today in the library.

One up on wall street is really a great reading! His style is more informal. Coupled with his wit and humor AND his enlightening advice, I think this is really a page turner for me. It mentioned on the front cover, "More than 1 million copies sold" - I think it is really that good to have sold a million copy.




There's so much information in this 300 page book that I do not know where to begin reflecting. I'm thinking of adding this book to my wish list of investment book that I would read again and again. Let's just start by reflecting on the points which lit up my proverbial light bulb.

1. I learnt the importance of placing the price of the chart against the earnings of the companies. This is not primarily to see how the market reacts to earnings, but to see how the earnings fluctuates. I 'practiced' this by Prime Success and Hongguo, but atlas, their earnings are too stable so it didn't show much. It'll be interesting to place a cyclical stock against the price.

2. Peter classifies stock into 6 general categories:

a. Slow growers

These are large and aging companies, with low earnings growth and usually large, regular dividends. I immediately think of yellow page. After thinking further, perhaps Singpost fall under here too.

b. Stalwarts

These are the 'blue-chip' quality stocks, with earnings around 10-12% growth. Risk is rather low for this type. Coca-cola, P&G from US side are quoted examples. I'm hard pressed to give an example in the local stock market. Help?

c. Fast growers

Smaller, aggressive companies growing 20-25% annually. Possibly a multi bagger, but with higher risk. Hongguo and China milk springs straight to mind.

d. Cyclicals

Companies whose sales and profits rise and fall in regular cycles. Construction plays come to mind. Tech stocks too.

e. Asset plays

Asset plays are companies that are sitting on a valuable asset but the rest of the crowd do not know. Hongfok (sitting on Concourse at Beach road), SPH (Paragon) are possible asset plays. Am I obsessed with singpost? Singpost might be possibly asset play too (sitting on Paya lebar site which they could dispose for a huge one-off gain).

f. Turnabouts

Those that have been depressed and battered, poised for a turnabout. Osim, creative comes to mind.


The book then goes on to list the pointers to look out when buying these 6 categories. There's even a section to tell you when to sell these 6 categories. All great stuff.

3. I think this is the most enlightening part. Peter's view on the growth of a stock and the PE struck me off as highly sensible. PE of any company that's fairly priced will equal to its earnings growth rate. That means that with a PE is 10x, then the earnings growth should be 10% growth. Some stocks are trading at breakneck 60x PE, so the question one needs to ask is that is the earnings growing at 60% too?

Peter suggests a more complicated formula to include dividends. Take the long term earnings growth rate, add the dividend yield, then divide by PE ratio.

If ratio < 1 ---- bad
If ratio around 1.5 ----okay
If ratio >= 2 ------- good

But if Company A grows at 10% with a PE of 10x is compared to Company B that grows at 30% with PE of 30x, even though both have a ratio of 1.0, Company B should be a better bet. Of course, this assumes all else being equal, which is ideal and never the case in practice.

EPS

Looking at the graph below, we can see that for the trio, earnings are pretty good and is consistently getting higher. I do find it strange that even though Hongguo’s portfolio is behind both Belle’s and Prime’s, its EPS is actually the highest among the three.


If this trend is sustainable, it doesn’t even matter to me if Hongguo is ranked 3rd or ranked 1st, since it’s the earnings that ultimately drive the company, not the market share of their brands, though both are usually correlated.

Hongguo’s EPS historical growth is around 25%. I did some calculations based on different periods of years to derive the CAGR and found that it’s pretty consistent, always hovering around 21 to 29% since inception. The CAGR shown below is actually for 5 year period since 2002 to 2007.


As for Prime’s, EPS historical growth rate is much higher and also less consistent compared to Hongguo. It grows at a 5-year CAGR of 62%, but the fluctuations of the CAGR for different periods vary from 22% to 41%. In other words, Prime’s EPS growth rate is high but less consistent than Hongguo.

Based on my previous post on Hongguo’s valuation, I projected the EPS in 2020 to be $2.04 and I know that the EPS for FY07 is $0.28. That gives us a projected CAGR of 16.5% over 13 years into the future. Comparing my projection with the historical EPS growth rate of 25%, I think it’s quite reasonable, considering that the historical EPS of Belle and Prime is well in excess of 60%. Even Prime’s more recent earnings growth rate of 33% (from 2006 to 2007) is way higher than my projected CAGR of 16.5% for Hongguo.

PE of Prime Success vs Hongguo

Prime’s historical PE ratio is shown below. It goes from a low PE of 1.1 times to a high PE of 42 times. But let’s just look at the more recent PE, it’ll be around 16.2 to 42 times. Last close of Prime Success is HKD 4.55, which gives it a PE (based on FY07 earnings) of 19.2 times. Prime’s FY06 to FY07 earnings is 32%.


On the other hand, Hongguo current PE is 10 times, with FY06 to FY07 earnings growing at 22%. According to Peter Lynch, PE of a fairly valued stock should be the same as the earnings growth rate. Dividing earnings growth rate by PE, a stock having 1.5 is considered good but having above 2 is a possible bargain. Following his line of thought, Hongguo will be quite undervalued at the current price, having a PE of 10x but an earnings growth rate of 22%. It should be more fairly valued around PE of 22 times. (22/10 = 2.2)

Similarly we can do the same for Prime. It is trading at PE of 19 times, but with earnings growth rate of 32%. (32/19 = 1.7).